PetSmart - Smart Time To Pick Up Some Shares

May.22.14 | About: PetSmart, Inc (PETM)


Shares sell-off as PetSmart is seeing a soft 2014, just like any other retailer.

PetSmart holds a dominant position in the stable and growing pet market.

Valuation is attractive as repurchases can continue given the rock solid balance sheet.

PetSmart's (NASDAQ:PETM) shares were hit hard on Wednesday following a soft first quarter earnings report which was accompanied by a relatively soft outlook for the rest of the year.

Shares offer appeal in my eyes after the sell-off. The company has a dominant market position, is attractively valued and operates with a rock-solid balance sheet.

First Quarter Headlines

PetSmart reported first quarter sales, which came in at $1.73 billion, up just 1.1% compared to the year before. Slow growth was the result of comparable store sales, which fell by 0.6%, which was a huge disappointment.

Reported earnings rose by $1.4 million to $103.8 million. Thanks to sizable share repurchases over the past year, earnings per share rose by 6 cents to $1.04 per share on a diluted basis.

Looking Into The Results

Investors as well as the company were not pleased with the sales results with topline growth being very limited despite the company net operating with 51 more stores compared to last year.

PetSmart faced a tiny bit of margin pressure with gross margins falling by 30 basis points to 30.7% of sales. This was offset by a strong operating performance with operating costs falling by 40 basis points to 20.8% of sales. Net income growth was limited due to a slightly higher tax rate.

Looking Ahead

For the current second quarter, PetSmart foresees comparable store sales to be flat or slightly negative. Earnings are seen between $0.92 and $0.96 per share.

Full year earnings are anticipated to come in between $4.29 and $4.39 per share. Net sales growth is seen in the low single digits on the back of approximately flat comparable store sales. Analysts were looking for annual earnings of $4.45 per share.

Valuing PetSmart

The company ended the quarter with $301 million in cash, equivalents and restricted cash. The company has no debt outstanding but is liable for $519 million in capital lease obligations.

At $57 per share, PetSmart's equity is valued at $5.7 billion, which values operating assets at around $5.4 billion. This values operating assets at roughly 0.8 times annual revenues foreseen just above $7 billion. The company trades at 12-13 times forecasted earnings after backing out the net cash position of the firm.

PetSmart pays a quarterly dividend of $0.195 per share for an annual dividend yield of 1.4%.

Strong Market Niche

PetSmart is the dominant leader in a growing multi-billion industry for petcare. The company has more than 1,300 stores serving consumers, which have the ability to buy some 11,000 exclusive and proprietary branded toys, apparel, bed, collars, supplement, food, containment and beauty products, among others.

The company holds a 17% share in the $35 billion market according to research from Nielsen as reported in last year's investor presentation. The market is large with 65% of U.S. households owning a pet as the company targets female, middle-aged and affluent consumers who really care about their pets.

The company's service business is large as well with the company facilitating 400,000 adoptions every year for instance. Other offerings include grooming and training services, among others.

Shareholder Returns

Over the past year, PetSmart has demonstrated a good mix of sales growth, gross margin expansion and cost containment on the operational side, resulting in a huge boost to earnings per share.

Despite this, the company continues to foresee revenue growth and is comfortable in its ability to maintain or increase operating margins. Combined with a rapid pace of share repurchases, a rock-solid balance sheet and an appealing valuation, the latest sell-off makes shares quite appealing in my opinion. This is despite softness witnessed in the first quarter and foreseen for the rest of the year.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PETM over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.